Assignment 1 – Diploma in IFRSs – 17 March 2014

SUGGESTED ANSWERS AND EXAMINER’S COMMENTARY

The suggested answers set out below were used to mark this question. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication. In
some questions, more marks were available than could be awarded for each requirement. This allowed
credit to be given for a variety of valid points or alternative calculations (based on valid assumptions) which
were made by candidates.

Question 1

Total Marks: 40

Examiner comments

Parts (a), (b), (d), (e) and (f) were generally well done.

In part (a) the sales tax was occasionally incorrectly calculated as 10% rather than 10%/110% of the gross
figure including sales tax.

Some candidate answers to part (c) simply stated the current process for standard setting rather than
critically appraising the process.

Candidate answers to part (g) often lacked depth, sufficient separate points and analysis.

(a)
The desktop computer and Windows 8 licence are treated as tangible assets, given that the
computer cannot operate without an operating system (IAS 38 paragraph 4).

The other software (Microsoft Office and AutoCAD) will be treated as intangible assets and
depreciated over their useful lives (2 years for Microsoft Office and 4 years for AutoCAD).

The sales tax is recognised as a separate receivable as it is recoverable.

At 31 December 2013, per computer:

$
Property, plant and equipment:
Computer equipment ((1,320 + 206.80)  100%/110%) = 1,388
– (1,388/4  6/12)) 1,214.50

Intangible assets:
Software - MS Office ((558.80  100%/110%) = 508 – (508/2  6/12)) 381.00
- AutoCAD ((7617.50  100%/110%) = 6,925 – (6,925/4  6/12)) 6,059.38
7,654.88

Total possible marks 6

Maximum full marks 6

(b)
Classic film Website Total
$'000 $'000 $'000
Carrying amount at 1 January 2013 4,000 60 4,060
Additions (W1) 70 215 285
Amortisation (W2) (185) (20) (205)
Disposals (60 – (W2) 15) (45) (45)
Carrying amount at 31 December 2013 3,885 210 4,095

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

At 31 December 2013
Cost/valuation (10,000 + 70)/(W1) 10,070 215 10,285
Accumulated amortisation
((10,000/5 x 3) + (W2) 185)/(W2) (6,185) (5) (6,190)
Carrying amount 3,885 210 4,095

Workings

1 Website development costs

$'000
Planning – expensed as akin to research per SIC-32 –
Registration of various domain names 18
Internal design costs 85
External contractor design costs 112
New content development - expensed because developed to market
the entity's own products (SIC-32 para 8) –
Advertising of new website - marketing expensed as no intangible asset
is created (IAS 38 para 69(c)) –
215

2 Amortisation

$'000
Classic film (4,000 + 70)/22 years 185

Website:
Old website (150/5 years x 6/12) 15
New website ((W1) 215/21½ years x 6/12) 5
20
205

Total possible marks 9½

Maximum full marks 8

(c) The current approach to standard setting involves a series of steps, not all of which are compulsory.
The compulsory steps are:

(1) Consultation with the Trustees and Advisory Council about the advisability of adding a topic
to the IASB's agenda

(2) Publication of an Exposure Draft for public comment, normally including a Basis for
Conclusions and the alternative views of dissenting IASB Board members

(3) Consideration of comments received on discussion documents and Exposure Drafts

(4) Approval of final standards by at least 10 of the 16 IASB members (or by 9 members if there
are fewer than 16 members)

(5) Publication of final standards with a Basis for Conclusions and dissenting opinions of IASB
Board members.

Criticisms of the current approach include:

(1) The IASB are slow to act. For example, the G20 pressed the IASB to act on impairment of
financial assets in April 2009, however revised proposals have not yet been finalised and they
are unlikely to be mandatory before 2017.

(2) The plethora of documents and exposure drafts is confusing and could be organised more
effectively, eg in quarterly batches given the timescales involved

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

(3) The IASB promised a period of calm between major standard changes, with major standard
changes being effective for annual periods beginning on or after 1 January 2005, 1 January
2009 and 1 January 2013. However, smaller changes effective from different dates have
confused preparers and users of the financial statements.

It has been suggested that a review every 3 years like the proposals for the IFRS for SMEs
would be sufficient.

(4) Long introduction periods combined with a general policy of permitting early application
creates inconsistency between financial statements. Early application could be prohibited in
the interests of consistency between companies.

(5) The use of Interpretations adds complexity to understanding IFRSs. As Interpretations tend to
be short, they could be included as an amendment to the particular standard.

(6) The current standard setting approach has not worked well with the piecemeal replacement
of the financial instruments standard. The result has been multiple versions of the standard,
each with early application permitted, but not requiring application of the subsequent changes
until the whole project is complete, creating confusion of which rules can and have been
applied by entities.

(7) Standards are grouped based on numbers determined by when they were issued rather than
by logical topics. The topics could be organised more logically like in the IFRS for SMEs.

(8) The IASB has bowed to political pressure, most notably from the United States, European
Union and financial institutions, that have promoted their own agendas (eg greater use of fair
values) which often conflict with the needs of other users of the financial statements (eg
domestic tax collection and the needs of smaller economies).

Total possible marks 9

Maximum full marks 6

(d) $'m
Property being constructed by Applet for future use as investment property 5.2
- investment property in the course of construction is investment property
(IAS 40 para 8(e)

Factory building let under an operating lease to Partlet –

– owner-occupied in consolidated financial statements

Former warehouse, unoccupied at the year end – future use to be determined 2.3
- investment property by default

Vacant land intended for the construction of a new warehouse for use by Applet –
in 2014 – not investment property (IAS 40 para 9(c))

Property owned by Partlet (subsidiary) let under an operating lease 3.0

to unrelated third parties – consolidated 100% as investment property
10.5

Total possible marks 5

Maximum full marks 5

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

(e)
US standards are currently a mixture of principles-based standards (some harmonised with IFRSs)
and traditional rules-based standards and are very complex. Replacing them with IFRSs would
simplify the system with a consistent principles-based system, reducing unnecessary detail.

US companies seeking global recognition are currently at a competitive disadvantage. Costs are
incurred in converting US GAAP to IFRSs for analysis purposes outside the US and an investor risk
premium may be attached to businesses not reporting under IFRSs.

Most other international important stock markets now use IFRSs. The USA is a notable exception.
Switching to IFRSs could boost investor confidence in US companies, and allow comparison with
the performance of other international companies without the need for reconciliations.

Use of IFRSs by US companies would have the side effect of educating US account preparers and
investors in IFRSs. This would make them more open to understanding international companies
with the potential for investment in them.

Use of IFRSs could represent a significant cost saving in not needing to develop detailed standards
and disclosures for listed companies. At the same time the US could play a bigger role in the
development of future IFRSs.

Total possible marks 5

Maximum full marks 4

(f)
DEF Tobacco Inc should be consolidated with a 20% non-controlling interest, despite the fact that
its business is very different from the rest of the group.

As DEF International plc's equity is traded in a public market, IFRS 8 segment disclosures for DEF
Tobacco Inc will be required. Adjustments must also be made to align its accounting policies with
IFRSs.

DEF Technick GmbH is a subsidiary reporting under IFRSs and as such should be consolidated,
with a 40% non-controlling interest.

Potenz GmbH is only 45% (60% x 75%) owned by DEF International plc. However it is controlled by
DEF International plc through its control of DEF Technik GmbH and therefore should be
consolidated with a 55% non-controlling interest.

DEF Mining Limited is jointly controlled with the Chinese government and should therefore be equity
accounted as a joint venture.

Total possible marks 5

Maximum full marks 5

(g)
(1) An 'incurred loss' model rather than an 'expected loss' model approach could be introduced,
whereby expected impairment losses factored into the pricing of the instrument are
recognised on initial recognition.

This would allow entities (and particularly financial institutions) to recognise impairment
losses earlier than under IAS 39 which requires 'objective evidence' to exist before an
impairment loss can be recognised. This approach has been criticised, particularly in the light
of the financial crisis, as being 'too little, too late'.

(2) For simple financial assets such as trade receivables, a different approach could be followed
such as recognising lifetime expected credit losses on initial recognition.

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

This would simplify impairment tests for many companies, as companies could use the
traditional approach of determining allowances for impairment losses by age and historical
loss rates.

(3) A common approach between IFRSs and US GAAP could be introduced.

This would allow comparability between entities reporting under the two GAAPs.

However, it looks like there will be a divergent accounting treatment between the two
standard setters, based on current proposals. The FASB favours upfront recognition of
lifetime expected losses and the IASB plans to limit impairment losses recognised on initial
recognition to lifetime expected losses multiplied by the probability of default in the following
12 months (ie, to act as a proxy for the expectation of losses factored into the pricing of the
instrument), and adjust them later as necessary.

Total possible marks 6

Maximum full marks 6
Maximum for the question 40

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

Question 2

Total Marks: 21

Examiner comments

Part (a) was well done although some answers did not appraise the current impairment process and
simply explained the existing rules.

Part (b) was also well done. Common issues were incorrect treatment of the restructuring costs and
interest payments, and allocation of the impairment losses to the trade receivables (which are outside the
scope of IAS 36).

Suggested solution

(a) The purpose of an impairment test is to ensure assets and groups of inter-related assets (cash-
generating units) are stated at no more than their recoverable amount, being the higher of fair value
less costs of disposal and value in use (present value of net cash inflows relating to the asset), ie
the best return the entity could generate by selling the asset or by retaining it to generate cash
flows in the business.

The value in use figure is very subjective given that it is determined by cash budgets from the
business, which by their nature, can only be audited in terms of their assumptions rather than the
actual cash flows.

The value in use figure is also influenced by the discount rate used. IAS 36 requires an entity to
discount at a rate that reflects the 'current market assessments of (a) the time value of money, and
(b) the risks specific to the asset for which future cash flow estimates have not been adjusted'.
Further guidance is given in Appendix A of IAS 36 (paras A15-A21) however the selection of the
discount rate is very much a matter of judgement which could lead to inconsistency between, and
manipulation by, companies. Being a 'market assessment' it is also subject to market fluctuations.

Fair value is determined using the criteria in IFRS 13 Fair Value Measurement and represents the
market value of the assets at a point in time, normally the year end, rather than a long-term value.
Some argue that this can cause short-term volatility in financial statements, given that assets are
normally held in a continuing business, not intending to sell them.

Both of these issues have been particularly evident recently as a result of changing asset values
and other financial variables in the wake of the financial crisis.

Practical difficulties may arise in determining the entity's cash-generating units and the allocation of
assets, corporate assets and goodwill between them.

Total possible marks 6

Maximum full marks 6

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

(b)
Carrying Carrying
amount Impairment Reallocation* amount
(before (after
Impairment) (impairment)
$'000 $'000 $'000 $'000
Property, plant and equipment 6,800 (W3) (253) 53 6,600
Goodwill 980 (W3) (980) –
Other intangible assets 1,700 (W3) (63) (53) 1,584
Trade receivables 520 520
Inventories 280 280
10,280 (1,296) (W1) 8,984

* Assets cannot be reduced below their fair value less costs of disposal (if known).

Workings

1 Recoverable amount

Higher of:
$'000
Fair value less costs of disposal
- overall 7,400
- individual separable assets (6,600 + 1,500 + 520 + 280) 8,900
Value in use (W2) 8,984

2 Value in use calculation

Discount rate adjusted for inflation = 1.0918/1.03 = 1.06

2014 2015 2016 2017 2018

$'000 $'000 $'000 $'000 $'000
Cash from sales 4,200 4,400 4,600 4,200 3,800
Cash paid to acquire inventories (1,680) (1,760) (1,840) (1,680) (1,520)
Wages and salaries costs (420) (420) (420) (420) (380)
Apportioned overheads attributable (200) (200) (200) (200) (200)
to division assets
Disposal on 31 December 2018 1,100
Payment of restructuring costs,
provided for at 31 December 2013 (1) –
Interest payments on loans (2) – – – – –
Tax payments (3) – – – – –
1,900 2,020 2,140 1,900 2,800
2 3 4 5
Discount rate 1.06 1.06 1.06 1.06 1.06

Discounted cash flows 1,792 1,798 1,797 1,505 2,092

Value in use $8,984,000 (to the nearest $1,000)

Notes:

(1) Interest cash flows are not included in the calculation because the cash flows are
discounted.

(2) Tax payments are not included as the impairment loss appears above the tax line in
profit or loss (IAS 36 para 50). (Instead, impairment losses could generate a deferred
tax adjustment if not recognised at the same time by the tax authorities).

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

3 Allocation of impairment losses

$'000
Carrying amount 10,280
Recoverable amount (W2) (8,984)
Impairment loss 1,296

$'000
(1) Goodwill 980
(2) Property, plant and equipment
(1,296 – 980 = 316 x 6,800/(6,800+ 1,700)) 253
Other intangible assets (316 x 1,700/(6,800 + 1,700)) 63
1,296

The full amounts allocated above are allocated to the property, plant and equipment and
other intangible assets as doing so does not reduce them below their fair value less costs to
sell of $6.6 million and $1.5 million respectively.

The trade receivables and inventories are outside the scope of IAS 36 (as any
impairment is covered by other standards).

Total possible marks 15½

Maximum full marks 15
Maximum for the question 21

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

Question 3

Total Marks: 12

Examiner comments

This question was the question with the lowest average mark on the paper.

Candidate answers often lacked analysis of the scenario and a number of answers missed the key issues,
ie that (a) was a financial liability (rather than cash-settled share-based payment) and that (b) included an
embedded derivative. Credit was however awarded for reasoned analysis of other conclusions.

Suggested solution

(a) The first issue here is whether the transaction should be accounted for as cash-settled share-based
payment or as a financial liability.

Cash-settled share-based payment is where 'the entity acquires goods or services by incurring a
liability to transfer cash or other assets to the supplier of those goods or services for amounts that
are based on the price (or value) of the entity’s shares or other equity instruments of the entity'
(IFRS 2 Appendix A).

The liability is not based on the price of the entity's shares. Instead it is fixed and is simply settled by
delivering one type of financial asset (equity instruments) rather than another (cash). Consequently
the arrangement is a financial liability as there is 'a contractual obligation to deliver cash or another
financial asset' (the equity instruments) (IAS 32 paragraph 11).

The financial liability will be measured at amortised cost as it is not held for trading purposes. The
$4 million should therefore be discounted to its present value and the equipment and liability initially
2
recognised at $3.63 million ($4m x 1/1.05 ).

Interest will be applied to the liability over the year and the interest of $0.1814 million ($3.628m x
5%) should be recognised as a finance cost in profit or loss.

Total possible marks 6

Maximum full marks 5

(b) This is an example of an embedded derivative arrangement.

An embedded derivative is 'a component of a hybrid contract that also includes a non-derivative
host – with the effect that some of the cash flows of the combined instrument vary in a way similar
to a stand-alone derivative'. (IFRS 9 para 4.3.1).

Here the 'host' contract is the property sale contract.

However, the house-builder also has the potential liability to refund the payment received if house
prices fall. This is dependent on an underlying variable (expected house prices) and is therefore
derivative as it meets the three criteria for a derivative in IFRS 9 Appendix A:

(a) Its value changes in response to the change in a specified interest rate, financial instrument
price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit
index, or other variable, provided in the case of a non-financial variable that the variable is not
specific to a party to the contract (sometimes called the ‘underlying’).

(b) It requires no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to
changes in market factors.

(c) It is settled at a future date.'

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

IFRS 9 requires embedded derivatives to be separated from host contracts which are not financial
assets and measured at fair value through profit or loss (like other derivatives) providing:

(a) the economic characteristics and risks of the embedded derivative are not closely related to
the economic characteristics and risks of the host;

(b) a separate instrument with the same terms as the embedded derivative would meet the
definition of a derivative; and

(c) the hybrid contract is not measured at fair value with changes in fair value recognised in profit
or loss.

The economic characteristics and risks of the sales contract and potential repurchase are not
closely related to each other, a derivative instrument could be entered into to give the same market
risk and the contract is not a financial liability measured at fair value through profit or loss.
Therefore, the embedded derivative must be separated from the property sale host contract.

Consequently the amounts received from the customer are separated into:

 Fair value of the option to put (i.e. sell) the property back to the developer
 Fair value of the property without the option

The sale of the house can be recognised as revenue as the IAS 18 Revenue criteria for revenue
recognition have been met as the significant risks and rewards of ownership have been transferred
to the buyer, and the house-builder does not retain continuing managerial involvement to the degree
normally associated with ownership nor effective control over the house sold, and the amounts
involved can be measured reliably.

The embedded option must be recognised as a liability at its fair value and remeasured to its fair
value at the 31 December 2013 year end, with changes being reported in profit or loss.

Total possible marks 14

Maximum full marks 12
Maximum for the question 12

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

Question 4
Total Marks: 27

Examiner comments

This question was entirely computational and similar to questions set in past assignments, with some
candidates earning very high scores.

Common problems areas included the fair value adjustments, calculation of the post-acquisition reserves up
to the date of the disposal and the profit on the disposal.

Some weak answers continued to consolidate the subsidiary at the year end, even though control had been
lost.

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

Pointer Group
Consolidated statement of financial position as at 31 December 2013
FV Post- Profit on Real-
Reverse FV adj Goodwill changes acq'n disposal ised Assoc
Parent Sub FV gain (W2) (W3) (W2) (W4) Disposal (W5) rev'n (W6) Consol
(80:20)
$'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000
Non-current assets
Property, plant & equipment 360,400 77,400 (77,400) 360,400
Investment in Sub - Cost 48,000 (48,000) –
- FV change 13,900 (13,900)
- Disposal (51,000) 51,000
Goodwill 4,900 (4,900) –
Other intangible assets 18,000 6,400 2,700 (1,650) (7,450) 18,000
Investment in associate 17,000 540 17,540
395,940
Current assets 131,400 20,600 1,400 (1,400) (20,600) 131,400
527,340

Equity attributable to owners

of the parent
Share capital 100,000 20,000 (20,000) 100,000
Share premium 84,000 8,600 (8,600) 84,000
Ret'd earnings – Parent 132,800 13,480 3,800 2,720 380 153,180
(64,200) (64,200)
– Sub 37,800 (16,500) (2,550) (16,850) (1,900) –
Investments in equity 13,900 (13,900) –
instruments reserve
Revaluation surplus – Parent 64,000 2,720 (2,720) 160 64,160
– Sub 9,600 (5,400) (3,400) (800) –
Fair value adjustments 3,600 (3,600) –
401,340
Non-controlling interests 11,000 3,370
680 (15,050) –
401,340
Liabilities 126,000 28,400 500 (500) (28,400) 126,000
527,340

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

Workings

1 Group structure

Pointer

1.1.2010 31.8.2013
16m – 12m = 4m
80% – 60% = 20%
$'000 $'000
Cost 48,000
Ret'd earnings 16,500 35,900 (37,800 – (5,700 x 4/12))
Rev'n surplus 5,400 8,800 (9,600 – (2,400 x 4/12))

Solita

2 Fair value adjustments

Measured at date of control

At acquisition Movement At disposal
1/1/2010 31/8/2013
$’000 $’000 $’000
Brands 2,700 (1,650) * 1,050
Inventories 1,400 (1,400) –
Contingent liability (500) 500 –
3,600 (2,550) 1,050
8
* 2,700/6 x 3 /12 years

3 Goodwill
$’000 $’000
Consideration transferred 48,000
Non-controlling interests (fair value) 11,000

Fair value of identifiable assets acq’d &

liabilities assumed at acq’n:
Share capital 20,000
Share premium 8,600
Retained earnings 16,500
Revaluation surplus 5,400
Fair value adjustments (W2) 3,600
(54,100)
4,900

4 Solita’s post acquisition reserves to 31 August 2013

Retained earnings
$’000
Retained earnings at 31 August 2013 (W1) 35,900
Fair value movement (W2) (2,550)
Retained earnings at acquisition (W1) (16,500)
16,850

Revaluation surplus
$’000
Revaluation surplus at 31 August 2013 (W1) 8,800
Revaluation surplus at acquisition (W1) (5,400)
3,400

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 Assignment 1 – Diploma in IFRSs – 17 March 2014

5 Profit on disposal of 60% of Solita

$'000 $’000
Fair value of consideration received 51,000
Fair value of investment remaining 17,000
Less: Net assets at date of disposal (76,000 – (8,100 x 4/12)) 73,300
Goodwill (W3) 4,900
Fair value adjustments (W2) 1,050
Less: Non-controlling interests
[(W3) 11,000 + (((W4) 16,850 + 3,400) x 20%)] (15,050)
(64,200)
3,800

6 Investment in associate

$’000
Cost (fair value at date control lost) 17,000
Share of post acquisition retained earnings (5,700 x 4/12 x 20%) 380
Share of post acquisition revaluation surplus (2,400 x 4/12 x 20%) 160
17,540

Total possible marks 27

Maximum full marks 27

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